DBRS Morningstar Confirms Texas Transportation Commission – IH 35E Managed Lanes Project at BBB (high) with a Stable Trend

DBRS Limited (DBRS Morningstar) confirmed its rating on the 35.5-year $285 million revenue loan (the TIFIA Loan), which was issued under the Transportation Infrastructure Finance and Innovation Act (TIFIA) program to fund part of the Texas Department of Transportation’s (TxDOT) Interstate Highway (I) 35 East (35E) Managed Lanes (MLs) Project (the Project), at BBB (high) with a Stable trend.

The rating confirmation stems from DBRS Morningstar’s view that the Project's financial metrics and liquidity remain relatively resilient despite the negative impact on future traffic and toll revenue from the Phase 2 project and the ongoing impact of the Coronavirus Disease (COVID-19) pandemic.

The Phase 2 project is part of the Texas Clear Lanes, which is a statewide strategic plan to provide congestion relief through nontolled roads and is focused on the five largest metro areas in Texas. Because the Project is TxDOT owned and operated, there are no provisions in the TIFIA loan agreement that prohibit TxDOT from improving traffic congestion in the catchment area. Construction of Phase 2 is expected to begin in 2022 and open for traffic in 2026. The scope of the Phase 2 project will consist of the full reconstruction and widening of I-35E from I-635 to the Denton County Line, approximately 6.39 miles. The general-purpose lanes will be widened to eight lanes from six (this was incorporated in DBRS Morningstar's previous forecast but the scope of Phase 2 has expanded materially), construction of continuous frontage roads, and reconstruction of the existing MLs (major reconfiguration of the existing MLs including ramp access from the frontage roads and eliminating the general-purpose lanes to the existing MLs ramp access south of President George Bush Turnpike). Moreover, DBRS Morningstar understands that the construction cost of the Phase 2 project is fully funded with cash by TxDOT and the Project will not provide any funding to the construction of the Phase 2 project.

CDM Smith assessed the impact of the Phase 2 project on the Project's traffic and toll revenue projection. From 2022 to 2025, the construction of the Phase 2 project is expected to reduce annual toll revenue on average by about 14% compared with CDM Smith's traffic and revenue (T&R) forecast in 2019. The long-term impact (2026 to 2052) is expected to reduce annual toll revenue and traffic on average by about 8% and 20%, respectively.

DBRS Morningstar believes the impact of the pandemic will likely subside as traffic and toll revenue continue on the path of recovery as public health restrictions continue to relax and more people return to the office. At this time, DBRS Morningstar believes there is still uncertainty of what a post-pandemic workplace may look like and how it could differ across industries. Although the change in traffic pattern induced by the pandemic has had a negative impact on toll revenue and is causing a slower recovery compared with traffic volume (at the end of Q1 2021, traffic volume was about 70% of the 2019 level and toll revenue was only 57% of the 2019 level), DBRS Morningstar notes that the monthly toll revenue has been rising faster since the beginning of the relaxation of public health restrictions in March 2021. Toll revenue increased by more than 33% and 15% in March 2021 and April 2021, respectively. Furthermore, CDM Smith believes this positive trend is likely to continue. According to the Kastle Systems, the office occupancy rate in Dallas metro has been steadily rising since March 2021 and as of the week of June 2, 2021, it is at 46%, which is significantly above the top 10 city average occupancy rate of 29%. The data suggests that there are more workers in the Dallas metro returning to the office than in other major cities in the country. Therefore, at this time, DBRS Morningstar's revised base-case scenario assumes that the coronavirus pandemic will not have a material impact on the long-term traffic and toll revenue projections on the Project.

For the 12 months ended December 31, 2020, the total number of toll transactions and toll revenue reached 19.1 million and $19.1 million, respectively. These results represent 66% and 63% of 2019 levels, respectively. The toll revenue in 2020 was slightly above DBRS Morningstar's base-case scenario of about $18 million or 60% of the 2019 level. Despite the higher-than-expected toll revenue in 2020, the pace of recovery has been lagging behind traffic recovery. At the end of Q2 2020, traffic was at about 41% of the 2019 level. It quickly recovered to about 62% at the end of Q3 2020 and steadily recovered to about 67% at the end of Q4 2020 and reached 70% of the 2019 level at the end of Q1 2021. However, the pace of recovery on toll revenue was noticeably slower and it only reached 57% of 2019 level at the end of Q1 2021. This could be attributed to the change in traffic pattern induced by the pandemic during the peak periods as the time frame of rush hour has changed compared with before the pandemic. As a result, there was insufficient traffic congestion during the peak periods to trigger the dynamic pricing mechanism to offset the decline in overall traffic in 2020. CDM Smith observed the toll rates in most segments during the peak periods were at around the minimum toll rates. However, in recent months, CDM Smith noticed the toll rates have been rising beyond the minimum toll rates more prominently in the evening (PM) peak period, suggesting a rise in traffic congestion on the MLs. In contrast, the toll rates during the morning (AM) peak period are not rising at the same pace as the toll rates in the PM peak period. CDM Smith believes this difference is attributed to the flexible work arrangements that many companies have implemented during the pandemic and a full return to the office has yet to happen. Therefore, people are still commuting to work at different times of the day (peak and off-peak periods) and as a result, there is less traffic congestion during the AM peak period.

Under the revised base-case scenario, DBRS Morningstar now projects toll revenue of about $22.1 million or 74% of the 2019 level in 2021, rising to 85% in 2022 and 106% in 2023. These revisions are a result of the ongoing pandemic impact and the construction impact of Phase 2 project (construction is expected to begin in 2022) and are in line with CDM Smith's updated projection. In addition, DBRS Morningstar is assuming a 13% reduction (in line with CDM Smith's updated projection) in annual toll revenue projection in 2024–25 plus additional reductions of 15% and 10% in annual toll revenue projection in 2024 and 2025, respectively. Furthermore, from 2026 to 2052, DBRS Morningstar assumes that toll revenue will decline on average by 8% annually (in line with CDM Smith's updated projection) once the Phase 2 project is complete plus an additional 10% decline in annual toll revenue to capture the risk of any future development along the corridor that may dampen traffic and toll revenue on the MLs. Based on DBRS Morningstar’s revised base-case scenario, DBRS Morningstar projects the TIFIA debt service coverage ratio (DSCR) to fall to 2.17 times (x) in November 2022 before rising to 2.59x in May 2023 and 2.89x in November 2023. After the Project's toll revenue has fully recovered to 2019 level in 2023, DBRS Morningstar projects a minimum TIFIA DSCR of 2.47x (May 2035). Despite the lower minimum TIFIA DSCR compared with DBRS Morningstar’s previous base-case forecast of 3.19x, DBRS Morningstar believes the weaker financial metrics (including the real toll revenue growth breakeven) remain in line with the rating.

DBRS Morningstar believes the Project has robust liquidity with more than $75 million in reserves (e.g., TIFIA Debt Reserve Fund, Operating & Maintenance Reserve Fund, Major Maintenance Reserve Fund, General Fund, Rate Stabilization Fund, and Revenue Fund) as at the end of April 2021. In DBRS Morningstar's revised downside case scenario, DBRS Morningstar believes there is still sufficient liquidity to weather any prolonged decline in traffic without affecting the Project’s ability to meet its debt service obligations in the next several years. Furthermore, the TIFIA DSCR is projected just slightly below 2.0x for one semiannual debt service payment date (November 2022) and to rise above 2.0x for the remainder of the recovery period (assume toll revenue to fully recover to 2019 level in 2024). Thus, DBRS Morningstar believes the Project is still relatively resilient under the revised downside case scenario.

DBRS Morningstar could take a positive rating action if traffic and toll revenues increase significantly over time, leading to a substantial improvement in the projected credit metrics. Conversely, DBRS Morningstar could take a negative rating action if the coronavirus pandemic causes a permanent shift in the traffic pattern that reduces the long-term traffic and toll revenue projections more than anticipated, resulting in compressed financial metrics that are no longer commensurate with the current rating. Furthermore, a change in tolling policy, a material improvement to local road networks, or other events that substantially depress T&R could result in a negative rating action.

ESG CONSIDERATIONS
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Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal methodology is Rating Public-Private Partnerships (August 19, 2020; https://www.dbrsmorningstar.com/research/365975), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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